Whether you are a First Time Home Buyer, or looking to make an upgrade into the home of your dreams, your front-end and back-end ratios play a large role in how large of a mortgage you qualify for. There are two ratios that are calculated to determine how much new debt (Mortgage Amount) you can service or afford to pay. In the residential finance industry, these ratios are called your front-end or housing ratio, and your back-end or expense ratio.
The housing ratio is comprised of the monthly expenses of owning a home, which is your principal and interest payment, monthly property taxes, homeowners insurance, mortgage insurance (if applicable) and the Home Owner Association (HOA) or assessments fee if the property is a condo or townhouse. The expense ratio is made up of your housing ratio as well as your other monthly recurring payments. The expense ratio will take into account all of your minimum credit card payments, car payments, student loans, alimony or child support. Although the ratio does not take into account other expenses, you should roughly add them in order to budget yourself accordingly.
If you are looking to obtain a mortgage under $417,000, the conventional loan limit, it is likely that your loan will be run through either the Fannie Mae or Freddie Mac automated underwriting system. These ratios historically are 28% for the housing ratio and 36% for the expense ratio. Although these are the primary ratios used, since the implementation of the credit scoring, with good credit these ratios can be expanded to as high as 35% for housing ratio and 49% for expense ratio.
The following are the explanations for the variables that will be taken into account when determining how large of a mortgage you qualify for:
Annual Income: The total money that you and the co-borrower earn throughout the standard fiscal year (January 1st – December 31st). Your Annual income includes base salary, commissions, bonuses, overtime, tips, rental income, investment income, alimony, child support, before all federal and state taxes are deducted.
Income Taxes: The total money deducted by the federal government, most states and some localities. The percentage of your income that must be paid as a tax is determined by your adjusted gross income and location specific laws.
Property Taxes: The amount of tax that is assessed by the county or locality in which your property is located. The tax is based on the size and value of the property as well as the land.
Homeowners Insurance: The form of insurance that protects your property against damages to both the building and the possessions inside. It also provides coverage for accidents that occur on the property.
Private Mortgage Insurance (PMI): The form of insurance that protects the lender if you default on your payments. The borrower is required to pay the premiums and the lender is the beneficiary. Most mortgage programs require you to purchase PMI if your down payment for the purchase price or value is less than 20%.
HOA Dues / Assessments: The amount of money that must be paid on a monthly basis to support the upkeep and expenses of a condominium building, townhouse development, or subdivision. This fee can include but is not limited to the expenses as doorstaff, landscaping, common area cleaning, utilities and a reserve fund for future large repairs. Although this is an essential expense of condominium buildings and townhouse developments, it is also found in exclusive subdivisions that have additional amenities and services for its residents.
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